Thermal coal futures so bright, you gotta wear shades

After crashing to levels last seen in the 2009 global financial crisis, spot market prices for Australian thermal coal delivered to power stations in southern China have shrugged off their aura of doom and gloom to trade at an 11-month high in June.

Prices for cargoes of Australian thermal coal with an energy content of 5,500 kcal/kg NAR for delivery to South China traded at $51.75/mt CFR June 27, the highest level since mid-July 2015, and up from a low of $42.50/mt last November, according to S&P Global Platts data.

FOB prices at Newcastle port for 5,500 kcal/kg NAR thermal coal cargoes have also recovered to $47.60/mt from a multi-year low of $37.50/mt in mid-November.

At the center of this stunning reversal of fortune is China’s coal futures market, which has grown explosively in terms of traded volumes over the past few months. For example, the September thermal coal contract on the Zhengzhou Commodity Exchange traded 79.4 million mt on June 27.

The Zhengzhou futures contract also has the feature that parties can deliver physical cargoes both domestic and imported against it, whereas some futures contracts for coal are only cash-settled.

Futures are now being used as a hedging tool by Chinese market players to offset price risk for their purchases of imported cargoes of fossil fuel.

Previously, China’s import market was governed by the rule of arbitrage. This required spot prices for domestic thermal coal at northern Chinese ports such as Qinhuangdao to always trade above delivered prices for imported thermal coal at China’s southern ports. Otherwise, deals for import cargoes could become loss making for the parties involved.

Now, with their ability to tap into the futures markets in China market participants can lock-in prices by selling futures contracts on a forward basis and buy cargoes in the physical market including imported cargoes from Australia.

This hedging trade protects market participants from the fall-out of adverse price movements. And, it is noticeable that the spread between prices for domestic and imported thermal coal with a calorific value of 5,500 kcal/kg NAR has disappeared from a high point of $6.50/mt back in February.

The rapid development of China’s coal futures market has surprised many traders and market analysts who did not expect thermal coal to become “commoditized” so quickly.

Some market experts have voiced concern at the price volatility in the China coal futures market, but with the market’s deep liquidity, some of it provided by small investors in China as well as banks, hedge funds and speculators, it is easy for market players to exit any unwanted market positions.

In short, the expanding coal futures market in China has opened the door to a new era in the world of trading thermal coal, and it could be said the market’s prospects are now brighter than they have been for a long time.